Finance

A decade after the financial crisis, mortgage market still needs fixes

Ten years ago we put Fannie Mae and Freddie Mac into conservatorships. The long sought government sponsored enterprises reform legislation to rein in Fannie and Freddie was passed and signed by President Bush only a month earlier. However, it was far too late to implement the necessary reforms. The new agency, Federal Housing Finance Agency, of which I was the director, regulated not just Fannie and Freddie, but also the Federal Home Loan Banks. These 14 institutions had $6.5 trillion of mortgages plus trillions of dollars of derivatives on their books as the housing market and prices across the nation were crashing down.

Although their financials did not show it, Fannie and Freddie were insolvent. Working with the Treasury and banking regulators, we spent the month of August 2008 building the case for conservatorship. With Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke beside me, we presented the case to the boards on September 6, and they approved it. The conservatorships worked thanks to the last minute addition of the famous "bazooka," allowing the Treasury to fund capital shortfalls of the government sponsored enterprises. The Treasury held more than $190 billion in their senior preferred stocks, plus options to own 79.9 percent of their common stocks.

With government support, Fannie and Freddie fulfilled their purpose of providing a countercyclical force to support the housing market and lessen the financial crisis. We pioneered a mortgage modification program, which later became the Home Affordable Modification Program. We created the Home Affordable Refinance Program to refinance underwater mortgages, helping four million homeowners.

The government sponsored enterprises market share of mortgages originated soared from about 30 percent to over 65 percent. Including Veterans Affairs and Federal Housing Administration mortgages, the government share approached 90 percent. Today the government share is almost 70 percent. Perhaps the conservatorships worked too well as Fannie and Freddie are still in them. Secretary Paulson called the conservatorships a "time out" that would last a year or two. The longest time out in the world had lasted far too long. It was time to play ball.

For the two years I ran the predecessor agency, I was criticized for actively pushing government sponsored enterprises reform. The present director of four and a half years has not done so. The government sponsored enterprises are becoming procyclical again, financing 3 percent down payment loans, expanding the types of loans they guarantee, expanding into new loan types, and loosening underwriting standards.

The Financial Crisis Inquiry Commission and others have studied what caused the meltdown. A fundamental cause is that Congress allowed them to buy or guarantee mortgages with only 1 percent capital. The Federal Housing Finance Agency recently proposed 2.5 percent capital, which is too low compared to banks. Another cause of the crisis was that the Department of Housing and Urban Development pushed the affordable housing goals for Fannie and Freddie to unrealistic levels.

Having gone through the financial crisis and recovery in the government then as an investor in banks and mortgage companies, here are some of my recommendations. First, reform must clearly separate the public sector and private sector roles in the mortgage market, with the public sector shrinking back to levels before the crisis over time. However, the existing Fannie and Freddie mortgage backed securities and bond investors must be protected. If Fannie and Freddie are recreated as solely private sector companies, they should be very well capitalized, supported by strong private sector mortgage insurance, credit risk transfers, and lower loan limits. They should pay state income taxes.

Another reform is that the government guarantee of commonly structured mortgage backed securities of the successors to Fannie and Freddie and other private sector companies, priced to reflect the risk, could be provided by either the Government National Mortgage Association or a new insurer as proposed in Senate legislation. Next, housing reform must consider the many government administrative agency roles in supporting affordable housing. Any affordable housing goals or funds should be set at realistic levels to support sustainable and affordable housing.

Finally, to help prevent harmful housing markets fluctuations, the capital requirements for the issuers of mortgage backed securities and the government guarantee should be countercyclical. That means if housing prices rise too far above long term trends, capital requirements and insurance premiums should be increased, and the availability of the government guarantee should be throttled back. If housing prices fall below trend lines, then the reverse should happen.

The housing market has fully recovered since the crisis. Homeowner equity has doubled to $15.7 trillion, while mortgage debt has been relatively flat at $10.6 trillion. If no changes are made, the Congressional Budget Office recently estimated that the government sponsored enterprises will guarantee $12 trillion in new mortgage backed securities over the next 10 years, costing us taxpayers $19 billion. There is no excuse for the continued massive government involvement in housing finance. As we did 10 years ago, the Federal Housing Finance Agency must work with Congress and the administration to reform the mortgage market.

James B. Lockhart is a senior fellow at the Bipartisan Policy Center. He served as the first director of the Federal Housing Finance Agency.

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